U.S. stocks posted the strongest week of gains since 2013 (would have been 2011 if not for late-day selling). The S&P500 surged 4.3%, and the Nasdaq Composite jumped 5.3%. The small cap Russell 2000 rallied 4.4%. After closing last Friday at 29.06, the VIX settled back down to a still elevated 19.46. Foreign markets recovered as well. Germany’s DAX rose 2.8%, and France’s CAC 40 gained 4.0%. The Shanghai Composite was closed for the lunar new year. The dollar index was back under pressure this week, sinking 1.5% and providing a boost to commodities prices. Price instability abounds.

While stocks rather quickly recovered a chunk of recent losses, the same cannot be said for corporate bonds. Notably, investment-grade bonds (LQD) rallied little after recent declines.

February 16 – Bloomberg (Cecile Gutscher and Cormac Mullen): “Corporate bond funds succumbed to rate fears that have gripped stocks to Treasuries. Investors pulled $14.1 billion from debt funds, the fifth-largest stretch of redemptions in the week through Feb. 14, according to a Bank of America Merrill Lynch report, citing EPFR data. High-yield bonds lost $10.9 billion alone, the second highest outflow on record. As benchmark Treasury yields traded at a four-year high, it shook the foundations of a key support for risk assets -- low rates. ‘Investors don’t sell their cash bonds in a big way until they are forced to, which happens when the outflows start picking up more sustainably,’ Morgan Stanley strategists led by Adam Richmond wrote…”

U.S. junk bond funds suffered outflows of $6.3 billion (from Lipper), the second highest ever. IShares’ high-yield ETF saw outflows of $760 million. U.S. investment-grade bond funds had outflows of $790 million (Lipper), the first outflows since September. This was a big reversal from last week’s $4.73 billion inflow. The iShares investment-grade ETF had outflows of $921 million, the “largest outflow in its 15-year history.” Even muni funds posted outflows ($443 million), along with mortgage and loan funds.

A strong equities rally into option expiration – following a bout of market selling and hedging - is not out of the ordinary. Hedges put on over recent weeks were unwound, creating potent buying power for the recovery. Scores of systematic trading strategies that were aggressively selling into market weakness turned aggressive buyers into this week’s advance.

I’m not much interested in sharing my guess as to where markets might head next week. It certainly wouldn’t be surprising if this week’s buyers panic subsides abruptly and selling reemerges. At the same time, I’ve seen enough of short squeeze and derivative melt-up dynamics to take them seriously. They have had a tendency of taking on a life of their own. I’m not, however, shying away from the view that recent developments mark a critical juncture in the markets – and for the world of finance more generally. Markets could find themselves in trouble in a hurry.

The objective for the CBB is to offer perspective. I believe the blowup of “short vol” and the revelation of how quickly the great bull market can succumb to illiquidity and losses have fundamentally altered the risk-taking and leveraging backdrop. The cost of hedging market risk, while down this week, has risen significantly. Treasuries have revealed themselves as an inadequate hedge against risk assets. Moreover, exceptionally high asset correlations experienced during the recent sharp selloff have illuminated the shortcomings of many so-called “diversified” strategies. There will be ebbs and flows, often wild and intimidating. Yet I believe de-risking/de-leveraging dynamics will gain momentum. Fragilities will be exposed.

I have serious issues with contemporary finance. Unique in history, the world operates with a financial “system” devoid of limits on either the quantity or quality of “money” and Credit. Unlike a gold standard (or other disciplined monetary regimes), there is no mechanism to contain the creation of new finance. As such, traditional supply/demand dynamics have little relevance in the pricing of finance. Today’s contemporary financial apparatus – where central bankers largely dictate the price of Credit – lacks effective regulation of supply and demand. Importantly, the contemporary system fails to self-correct or adjust. Left unchecked, it feeds serial Bubbles and busts.

Early CBBs focused on the instability of this new world of “Wall Street finance.” Unfettered finance, much of it directly targeted to asset markets, had created powerful asset inflation and Bubble Dynamics. Indeed, by the late-nineties the perilous instability of contemporary finance had become abundantly clear. One could point to “portfolio insurance” contributing to the ’87 crash; the role of non-bank finance in late-eighties excess; the 92/93 bond/derivatives Bubble that burst in 1994; the 1995 Mexican collapse; the ’97 Asian Tiger collapses; and the spectacular simultaneous 1998 Russia and Long-Term Capital Management debacles.

Somehow, there’s never been a serious and sustained effort to analyze contemporary finance’s shortcomings. Rather than contemplating evident deficiencies, each burst Bubble led immediately to whatever reflationary measures deemed necessary. Structural issues be damned. All along the way, few have been willing to admit the fundamental flaws inherent in various modern forms of risk intermediation. Rather than mitigate risk, structured finance and derivatives tend to distort, disguise and transfer myriad risks. Various risk intermediation mechanisms work to lower the cost of finance, in the process exacerbating Credit excess, risk-taking, speculation and leveraging.

Perhaps most momentous, the experiment in unconstrained finance spurred an experiment in economic structure. The U.S. economy was free to deindustrialize. With newfound access to unlimited finance and inflating asset prices, Americans were to indefinitely trade financial claims for endless cheap imports. The bane of “twin deficits” had been eradicated. Even more miraculously, the flood of finance the U.S. unleashed upon the world would, largely through foreign central banks, be recycled right back into booming American securities markets.

After the burst of the “tech” Bubble – and, importantly, the 2002 dislocation in the corporate debt market – the Fed panicked. Even more so than 1987, 1990 and 1998, the Fed feared “the scourge of deflation.” Somehow, the Fed, Wall Street and others found solace in Bernanke’s radical monetary ideas of “helicopter money” and the “government printing press.” The Federal Reserve was willing to slash rates to one percent – and leave them pegged there in the face of several years of double-digit annual mortgage Credit growth.

Let’s call it what it was: reckless. The Fed looked the other way from conspicuous financial and housing-related excess (as they have in the securities markets more recently). Why? Because they had specifically targeted mortgage Credit as their inflationary mechanism of choice. The Bubble was Untouchable.

The ‘08/’09 crisis should have provided an historic inflection point. The greatest upheaval in decades should have marked the beginning of an era of more stable finance – of sounder money and Credit and firmer economic underpinnings. It would have no doubt been an arduous process. Central bankers had other ideas.

I’ve never been tempted to give up on the analysis. For going on ten years, I’ve chronicled the greatest experiment in the history of central banking. Central bankers have adopted the most extreme rate, “money printing,” and market manipulation measures ever. They have guaranteed abundant cheap (virtually free) finance for about a decade now. What was meant to be a temporary rescue of fragile private-sector, market-based finance morphed into history’s greatest global Bubble.

The greatest flaw in central banker doctrine/strategy was to believe that after intervening temporarily with reflationary measures the system would stabilize and gravitate right back to normal operations. Central bankers reflated a deeply unsound financial structure, only exacerbating flaws and compounding contemporary finance’s vulnerabilities. In particular, a decade of reflationary measures profoundly inflated risk intermediation distortions and fragilities.

The “Moneyness of Risk Assets” has seen Trillions flow into an untested ETF complex on the assumption that central bankers would ensure ETF holdings remained a safe and liquid store of value. Reflationary measures also incentivized Trillions to flow into sovereign debt, corporate Credit, structured finance and the emerging markets on the belief that central bankers would not tolerate another market crisis. Trillions have flowed into various derivative trading strategies on the view that central bankers would ensure liquid and continuous markets – no matter the degree of market excess.

The upshot has been market distortions and the accumulation of risks on an unprecedented scale. Fragilities have surfaced on occasion (i.e. “flash crashs”), spooking the central banker community sufficiently to ensure that “temporary” reflationary measures evolved into Permanent Market Support Operations. Central bankers had slipped fully into the markets’ trap. Cautious measures expected to normalize policy over time only ensured that financial conditions loosened further - and global Bubble inflation accelerated.

Along the way, Permanent Market Support Operations changed the game – in global finance as well as throughout economies. Everyone was free to assume more market risk – savers, investors, pension funds and institutions, and the leveraged speculator community. Corporate management could issue more debt and buy back more stock. Easy “money” ensured an easy M&A boom. It took time, but animal spirits in the Financial Sphere eventually manifested in the Real Economy Sphere.

The most aggressive companies, managers, entrepreneurs and swindlers all enjoyed the greatest success. Seemingly any clever idea could attract funding. With finance virtually unlimited and free, almost any investment could be viewed as having merit irrespective of prospects for economic returns. There was abundant “money” to be thrown at everything – the cloud, the Internet of things, AI, robotics, autonomous vehicles, all things tech, pharmaceuticals, alternative energy, all things media and so on. It became New Paradigm 2.0, with the earlier nineties version now such a triviality.

Things just got too crazy. Central bankers were much too complacent as Bubble Dynamics gathered powerful momentum. Booming asset inflation and 4% unemployment weren’t enough to convince the Fed it was time to tighten up the reins. Meanwhile, the ECB and BOJ clung stubbornly to negative rates and massive QE programs. Chinese Credit went nuts. Awash in international flows, EM just kept borrowing. Through it all, wealth disparities only worsened, fueling in the U.S. a populist movement and anti-establishment revolt that placed the Trump administration in power. Despite a massive accumulation of debt and ongoing large deficits – not to mention increasingly overheated late-cycle economic dynamics - the Republicans pushed through historic tax cuts. Next on the President’s agenda: tariffs and trade battles.

Everyone became so transfixed by daily stock market records, historically low volatility and the easiest conditions imaginable throughout corporate Credit. It was easy to ignore pressures percolating on the inflation front. And it became just as easy to disregard the possibility that central bankers might actually raise rates to the point of tightening financial conditions. Heightened uncertainty began to manifest in currency market volatility. Meanwhile, excesses were mounting in the securities markets on a daily basis – including incredible flows into perceived safe and liquid ETFs, rank speculation, “short vol,” derivatives and leverage.

For the most part during this extraordinary cycle, Monetary Disorder has remained conveniently contained within the securities and asset markets, seemingly staying within the purview of global central bank policymaking. Rather suddenly, however, markets are beginning to realize there are unfolding risks not easily resolved by monetary stimulus. Deficit spending has become completely unhinged, while inflation is gaining sufficient momentum to garner concern. As such, central bankers may feel compelled to actually tighten financial conditions. Bond markets are on edge, commencing a long-overdue price adjustment. At the minimum, the Fed and others will likely be less hurried when coming to the defense of unstable equities markets.

The bulls see this week’s quick stock market recovery as confirmation of sound underlying fundamentals. The selloff was a technical market glitch completely detached from the reality of booming corporate earnings, robust economic growth and extraordinary prospects.

I see this week’s big market rally as confirmation of the Bubble thesis. Markets have lost the capacity to self-adjust and correct. Derivatives and speculation rule the markets. Option expiration week certainly provides fertile ground for short squeezes and the crushing of put holders. But it does raise the important question of whether markets at this point can correct without dislocating to the downside. I have serious doubts. The quick recovery has markets again dismissing mounting risks. Perhaps it will also keep the Fed thinking economic risks are tilted to the upside – that they need to ignore market volatility and stay focused on normalization.

My view is that normalization is impossible. Extended global market Bubbles are too fragile to endure a tightening of financial conditions. At the same time, sustaining Bubbles has become perilous. Especially in the U.S., with deficits and a weak currency as far as the eye can see, the risks of allowing inflation to gain a foothold are significant. For the first time in a while, there is pressure on the Fed to actually tighten financial conditions. This places the great central bank experiment at risk. Bubbles don’t work in reverse.

The world is changing. These flows out of corporate debt ETFs are a significant development – another step toward “Risk Off.” Speculative and hedging dynamics that hit equities hold potential to spark major dislocation and illiquidity in corporate Credit. For further evidence of change, look no further than a Tuesday headline from the Wall Street Journal: “White House Considering Cleveland Fed President Mester for Fed’s No. 2 Job.” A central banker I admire considered for a top Fed post? Is this part of a changing of the guard at our central bank, or perhaps administration officials recognize that with years of huge deficits looming on the horizon, along with dollar vulnerability, the Fed will soon be in need of some inflation-fighting credentials.

The U.S. dollar index dropped 1.5% to 89.10 (down 3.3% y-o-y). For the week on the upside, the South African rand increased 3.4%, the Japanese yen 2.4%, the Norwegian krone 2.3%, the Brazilian real 2.2%, the New Zealand dollar 1.8%, the British pound 1.4%, the Swedish krona 1.4%, the South Korean won 1.4%, the Singapore dollar 1.3%, the euro 1.3%, the Swiss franc 1.3%, the Australian dollar 1.2%, the Mexican peso 1.0% and the Canadian dollar 0.2%. The Chinese renminbi declined 0.6% versus the dollar this week (up 2.61% y-t-d).

February 11 – Bloomberg (Rachel Evans): “You just can’t keep a good trade down. The ProShares Short VIX Short-Term Futures fund, which lost more than 80% of its value on Feb. 6, took in the most cash on record last week. The product, which goes by the ticker SVXY, was the fifth-most popular exchange-traded fund in the U.S., absorbing more than $500 million…”

February 12 – Bloomberg (Luke Kawa): “Brave volatility traders are betting that lightning won’t strike twice. Two of the three most active options tied to the iPath S&P 500 VIX Short-Term Futures exchange-traded note (VXX) on Monday were way out-of-the-money calls. The major explosion of open interest in these options occurred in transactions that took place closer to the bid than to the ask price, which implies that this was motivated selling rather than fresh bets on another volatility spike. Volatility sellers are likely emboldened by signs the market’s fever is breaking. The Cboe Volatility Index… has roughly halved from last week’s peak, and U.S. stocks are up nearly 5% from their Feb. 9 lows.”

February 11 – Bloomberg (Luke Kawa and Joanna Ossinger): “Investors actively abandoned the world’s biggest passive fund during the onset of market mayhem. The SPDR S&P 500 exchange-traded fund (ticker SPY) suffered a record $23.6 billion in outflows last week amid the worst momentum swing in history for the underlying U.S. equity benchmark. Outflows amounted to 8% of the fund’s total assets at the start of the week, a rate of withdrawals not seen since August 2010.”

February 11 – Wall Street Journal (Alistair Gray and Robin Wigglesworth): “Wall Street is pointing the finger at insurance companies as an unlikely but pivotal source of the turbulence that wiped trillions of dollars off stock market values in recent days. While complex volatility-linked funds and algorithmic traders have been widely blamed for the wild price swings, strategists and investors said a significant portion of the selling could be traced to variable annuities, a popular tax-advantaged insurance-company product that offers customers guaranteed returns. US life insurers suffered losses on variable annuities in the financial crisis. Since then, insurers have responded by marketing variable annuities that put customers’ money into ‘managed volatility’ funds. These vehicles, which aim to produce steadier returns, shed risky assets when volatility spikes.”

February 12 – Wall Street Journal (Asjylyn Loder and Dave Michaels): “The recent implosion of two exchange-traded products is renewing questions about the impact of fast-growing passive funds on the markets they are meant to track. While exchange-traded funds have lowered the cost of investing and given individuals access to strategies once reserved for hedge funds and multibillion-dollar pensions, the $5 trillion global industry has ventured into complex strategies, sometimes with disastrous results. The latest example came on the evening of Feb. 5, as ETPs that bet against Wall Street’s fear gauge lost more than 80% of their value. The strategy has been a popular moneymaker in recent years as stocks marched steadily higher, keeping the Cboe Volatility Index, known as the VIX, at near-record lows.”

Trump Administration Watch:

February 13 – Bloomberg (Steven T. Dennis): “President Donald Trump’s budget blueprint doubles the deficits he forecast a year ago with little expectation they’ll shrink anytime soon. As a result, the $20 trillion federal debt that Trump railed against as a candidate is projected to balloon to $30 trillion a decade from now. And that’s despite the healthy dose of economic optimism in Monday’s budget: 3% growth, low inflation, low interest rates and low unemployment each year. It also assumes trillions in spending cuts Congress has already rejected… The prospect of encroaching inflation and higher interest rates contributed to the biggest stock market rout in two years. Investors who spent January celebrating Trump’s tax package with the biggest rally since 1997 watched as those gains dissolved, leaving the S&P 500 back where it was in November.”

February 12 – Politico (Theodoric Meyer): “Deficit spending is officially back in style, leaving Washington’s professional deficit scolds wondering how they’ll manage to persuade lawmakers to care about red ink again. The one-two punch of Republicans’ recent tax cuts and the bipartisan, two-year budget deal Congress passed last week could boost the next fiscal year's deficit — the difference between what the government spends and what it collects in taxes — to more than $1 trillion, according to projections. That’s caused a mixture of alarm and depression among the think tanks and foundations that have spent years pushing Congress to shrink the annual deficits.”

February 13 – Reuters (Roberta Rampton and David Lawder): “U.S. President Donald Trump said… he was considering a range of options to address steel and aluminum imports that he said were unfairly hurting U.S. producers, including tariffs and quotas. Trump's comments - his strongest signal in months that he will take at least some action to restrict imports of the two metals - came in a meeting with a bipartisan group of U.S. senators and representatives… Some of the lawmakers urged him to act decisively to save steel and aluminum plants in their states, but others urged caution because higher prices would hurt downstream manufacturers that consume steel and aluminum.”

February 14 – Bloomberg (Joe Light): “Fannie Mae will request an infusion of taxpayer money for the first time since 2012 because of an unintended but anticipated side effect of the corporate tax cut signed into law in December. The mortgage-finance company… said it will need to draw $3.7 billion from the U.S. Treasury in March to keep its net worth from going negative. The deficit was driven by a $6.5 billion loss in the fourth quarter, which came as a result of a drop in the value of assets Fannie can use to offset taxes. The assets became less valuable when Congress cut the corporate tax rate, resulting in a $9.9 billion hit.”

February 13 – Reuters (Katanga Johnson and Susan Cornwell): “The White House budget chief said… that, if he were still a member of Congress, he ‘probably’ would vote against a deficit-financed budget plan he and Trump are proposing. At a U.S. Senate panel hearing where he defended the administration’s new $4.4-trillion, fiscal 2019 spending plan, Mick Mulvaney was asked if he would vote for it, if he were still a lawmaker… ‘I probably would have found enough shortcomings in this to vote against it,’ said Mulvaney, director of the U.S. Office of Management and Budget (OMB)…”

U.S. Bubble Watch:

February 13 – Financial Times (Demetri Sevastopulo): “Dan Coats, the top US intelligence official, urged Congress to tackle the ballooning national debt, saying it posed a ‘dire threat’ to economic and national security. In presenting Congress with the US intelligence community’s annual global threat assessment — which ranged from the nuclear crisis on the Korean peninsula to Russian interference in US elections — Mr Coats called for action to prevent a ‘fiscal crisis . . . that truly undermines our ability to ensure our national security’. ‘The failure to address our long-term fiscal situation has increased the national debt to over $20tn,’ Mr Coats, the director of national intelligence, told the Senate intelligence committee. ‘This situation is unsustainable . . . and represents a dire threat to our economic and national security.’ His warning came a day after President Donald Trump released his budget proposal for fiscal 2019, which jettisoned a pledge from a year ago to eliminate the budget deficit over 10 years.”

February 15 – Bloomberg (Katia Dmitrieva): “Three measures of price pressures for American businesses showed they’re facing higher production costs, adding to evidence that inflation is creeping up in the U.S. economy. The Empire State Manufacturing prices-paid index increased 12.4 points to 48.6 in February, the highest level since 2012… A separate index from the Philadelphia Fed showed prices paid in that region also surging in February, reaching the highest since May 2011… In Washington, …U.S. wholesale prices rose in January on costs of energy and hospital services. The producer-price index increased 0.4% from the prior month…”

February 13 – Bloomberg (Prashant Gopal): “Home prices jumped to all-time highs in almost two-thirds of U.S. cities in the fourth quarter as buyers battled for a record-low supply of listings. Prices for single-family homes, which climbed 5.3% from a year earlier nationally, reached a peak in 64% of metropolitan areas measured, the National Association of Realtors said... Of the 177 regions in the group’s survey, 15% had double-digit price growth, up from 11% in the third quarter… While prices jumped 48% since 2011, incomes have climbed only 15%, putting purchases out of reach for many would-be buyers.”

February 16 – Reuters: “U.S. import prices rose more than expected in January as the cost of imported petroleum and a range of other goods increased, which could boost inflation in the coming months. …Import prices jumped 1.0% last month after an upwardly revised 0.2% rise in December.. In the 12 months through January, import prices increased 3.6%, the largest advance since April 2017, quickening from a 3.2% rise in December.”

February 13 – CNBC (Tae Kim): “The American consumer is loading up on debt. Total household debt rose by $193 billion to an all-time high of $13.15 trillion at year-end 2017 from the previous quarter, according to the Federal Reserve Bank of New York's Center for Microeconomic Data report… Mortgage debt balances rose the most in the December quarter rising by $139 billion to $8.88 trillion from the previous quarter. Credit card debt had the second largest increase of $26 billion to a total of $834 billion. The report said it was fifth consecutive year of annual household debt growth with increases in the mortgage, student, auto and credit card categories.”

February 13 – Bloomberg (Luzi-Ann Javier): “Optimism among small companies in the U.S. rose more than forecast in January, fueled by a record number of owners who said now was a good time to expand, according to a National Federation of Independent Business survey… Overall index rose by 2 points to 106.9 (est. 105.3), close to November’s 107.5 reading that was highest in monthly data to 1986.”

February 12 – Bloomberg (Matthew Boesler): “U.S. consumers said they expected to see the fastest wage growth in several years when polled in January, according to a monthly Federal Reserve Bank of New York survey. Consumers polled expected earnings to rise 2.73% in the coming year, the most since data collection began in 2013, according to results of the New York Fed’s Survey of Consumer Expectation... January was only the third month in the survey’s 56-month history in which expected wage growth topped expected consumer price inflation, which fell slightly, to 2.71%.”

February 13 – New York Times (Conor Dougherty): “The United States is on track to achieve the second-longest economic expansion in its history. Unemployment is at a 17-year low. And California’s state budget has a multibillion-dollar surplus. So why is its longtime governor, Jerry Brown, issuing prophecies of doom? ‘What’s out there is darkness, uncertainty, decline and recession,’ Mr. Brown said recently after presenting his final budget to legislators. California has accounted for about 20% of the nation’s economic growth since 2010… nBut Mr. Brown, in his final year in office, has raised the question on the minds of those paid to think about the economy: How long can this last? For California and the nation, there is a long list of things that could go wrong. A surging budget deficit could stoke higher interest rates. And if the recent upheaval in stocks signals a longer-term decline, it would hurt California in particular because its budget relies heavily on high earners whose incomes rise and fall with the market… In 2009, as the last recession took hold, California state revenue fell 19%, versus 8% for state revenues nationwide, according to Moody’s Analytics.”

February 14 – Bloomberg (Sho Chandra): “U.S. retail sales unexpectedly declined in January and December receipts were revised lower, indicating consumer demand in the first quarter may cool… Overall sales fell 0.3% (est. 0.2% gain), the most since February 2017, after little change in prior month (prev. 0.4% increase). Purchases at automobile dealers dropped 1.3%, the most since August.”

February 13 – Wall Street Journal (Gunjan Banerji): “A U.S. regulator is looking into whether prices linked to the stock market’s widely watched ‘fear index’ have been manipulated, according to people with knowledge of the matter. The Cboe Volatility Index, known as the VIX, is derived from S&P 500 options prices. The Financial Industry Regulatory Authority is scrutinizing whether traders placed bets on S&P 500 options to influence prices for VIX futures… Separately, a letter from a law firm Monday representing an unidentified client urged U.S. regulators to investigate VIX manipulation, claiming it has cost investors hundreds of millions of dollars in losses each month.”

Federal Reserve Watch:

February 14 – CNBC (Jeff Cox): “U.S. consumer prices rose considerably more than expected in January, fueling fears that inflation is about to turn dangerously higher. The Consumer Price Index rose 0.5% last month against projections of a 0.3% increase… Excluding volatile food and energy prices, the index was up 0.3% against estimates of 0.2%. The report indicated that price pressures were ‘broad-based,’ with rises in gasoline, shelter, clothing, medical care and food. Markets reacted sharply to the news.”

February 13 – Financial Times (Demetri Sevastopulo, Sam Fleming and Robin Wigglesworth): “The White House is considering appointing Loretta Mester, president of the Federal Reserve Bank of Cleveland, as vice-chair of the US Federal Reserve’s board of governors. One person familiar with the selection process for the powerful central banking role said White House officials had discussed the job with Ms Mester and were ‘impressed’ with her. However, the person stressed that there was currently no frontrunner for the position…”

February 13 – Reuters (Howard Schneider): “The recent stock market sell-off and jump in volatility will not damage the economy’s overall strong prospects, Cleveland Fed president Loretta Mester said… in warning against any overreaction to the turbulence in financial markets. ‘While a deeper and more persistent drop in equity markets could dash confidence and lead to a pullback in risk-taking and spending, the movements we have seen are far away from this scenario,’ Mester said of a market rout…”

February 14 – Wall Street Journal (Justin Lahart): “With the economy throwing off more heat, the biggest risk for the Federal Reserve is that it falls behind on raising interest rates. And if investors suffer as a result? So be it. Inflation picked up again last month. The Labor Department on Wednesday reported that consumer prices rose 0.5% in January from December, putting them 2.1% above their year-earlier level. Core prices, which exclude food and energy, rose 0.3% for a 1.8% gain on the year. Both measures were stronger than economists expected.”

China Watch:

February 12 – Reuters (Kevin Yao, Fang Cheng): “China’s banks extended a record 2.9 trillion yuan ($458.3bn) in new yuan loans in January, blowing past expectations and nearly five times the previous month as policymakers aim to sustain solid economic growth while reining in debt risks. While Chinese banks tend to front-load loans early in the year to get higher-quality customers and win market share, the lofty figure was even higher than the most bullish forecast… Net new loans surpassed the previous record of 2.51 trillion yuan in January 2016, which is likely to support growth not only in China but may underpin liquidity globally as major Western central banks begin to withdraw stimulus… Corporate loans surged to 1.78 trillion yuan from 243.2 billion yuan in December, while household loans rose to 901.6 billion yuan in January from 329.4 billion yuan in December…”

February 11 – Wall Street Journal (Manju Dalal, Shen Hong and Chuin-Wei Yap): “An engine of consumer loan growth in China is slowing. But that might not be such a bad thing, at least for regulators and market participants that have fretted about a rise in risky lending practices over the past year. China’s market for asset-backed securities—which bundle up car loans, mortgages, consumer loans and other receivables into bondlike products—surged in 2017, led by issuers including the financial affiliate of Alibaba Group Holding Ltd. and other nonbank lenders. Total issuance of such instruments, which are mostly denominated in yuan, jumped 90% to over $220 billion last year from 2016, according to S&P Global.”

February 13 – Bloomberg (Yuko Takeo and Yoshiaki Nohara): “Debt-laden Chinese conglomerate HNA Group Co. had its credit assessment cut for the second time in less than three months by S&P Global Ratings, which cited significant debt maturities amid deteriorating liquidity. Separately, some HNA directors and top executives have purchased offshore dollar bonds guaranteed by the group… The company is in a ‘very healthy’ financial position, it said. S&P lowered HNA’s credit profile to ccc+ from b.”

February 12 – Bloomberg: “HNA Group Co., the once-voracious hunter of global trophy assets, is seeking to sell more than $6 billion in properties worldwide as pressure intensifies for the Chinese conglomerate to speed up disposals so it can repay its debts. The group… said it agreed to sell two plots of land in Hong Kong it bought less than a year ago for HK$16 billion ($2 billion) to the city’s second-richest man. HNA is also said to have been in talks to sell a pair of office buildings in London’s Canary Wharf district it bought for more than $500 million and offering a raft of properties in the U.S. valued at about $4 billion.”

February 11 – Bloomberg: “Billionaire Hui Ka Yan’s China Evergrande Group, the nation’s number three by sales last year, has started selling homes cheap. A 12% discount will apply to many apartments ahead of a week-long Chinese New Year holiday… Sweeteners include down-payments by installment. The company may see headwinds for the property market amid local governments’ stringent home-buying curbs and the potential for liquidity to tighten. One analyst’s theory: this is a bid to please a government determined to cool housing prices, ahead of a long-standing plan to list a property unit on the mainland.”

February 11 – Wall Street Journal (Scott Patterson and Russell Gold): “Miners push bicycles piled high with bags of a grayish-blue ore along a dusty road to a makeshift market. There, they line up at wholesalers with nicknames such as Crazy Jack and Boss Lee. Most of the buyers are Chinese. Those buyers then sell to Chinese companies that ship the bags, filled with cobalt, to China for processing into rechargeable, lithium-ion batteries that power laptops and smartphones and electric cars. There is a world-wide race to lock up the supply chain for cobalt, which will likely be in even greater demand as electric-car production rises. So far, China is way ahead.”

Central Bank Watch:

February 11 – Reuters (John Miller): “The European Central Bank is concerned that the United States is exerting ‘political influence’ on exchange rates and will make this a theme at upcoming G20 meetings, ECB policymaker Ewald Nowotny said… ‘We in the ECB are certainly concerned about attempts by the United States to politically influence the exchange rate,’ Nowotny told Austrian broadcaster ORF. ‘That was a theme of economic discussions in Davos, where the ECB addressed this, and it will certainly be a theme at the upcoming G20 summit.’”

Global Bubble Watch:

February 12 – Bloomberg (Cecile Gutscher): “Societe Generale SA is telling yield-seeking bond investors to give up the ghost: they can no longer bank on dormant inflation underpinning risk bets, from credit to emerging markets to long-dated government debt. ‘The bear market in rates has started, and with it credit, and eventually emerging markets, should both come under pressure,’ strategists led by Brigitte Richard-Hidden wrote… ‘There has been a regime shift in the market, which implies further increases in yields.’”

February 10 – Financial Times (Chris Flood): “Investors ploughed more than $100bn in new cash into exchange traded funds in January, a record monthly inflow that helped drive assets held in ETFs globally above the $5tn mark for the first time. The surge in January follows four consecutive years of record breaking inflows into ETFs, a tectonic shift that is sending shockwaves across the entire asset management industry… Net new inflows into exchange traded funds and products reached $105.7bn in January, according to… ETFGI…”

February 13 – Financial Times (Joe Rennison and Eric Platt): “The premium investors are demanding to own loans that are packaged into bonds has tumbled to the lowest since the financial crisis, in a sign that the market has not been roiled by the return of volatility in stocks. The market for collateralised debt obligations, as the securities are known, has boomed over the past two years as the juicier yields they offer draws buyers. That, in turn, has driven the issuance of collateralised loan obligations that this year has already eclipsed the record pace of 2017. Barings… priced a $517m CLO — composed of loans made to weaker corporate borrowers — at the lowest spread over a benchmark interest rate since 2008. The safest triple A part of the CLO priced at just 99 bps above Libor…”

February 11 – Reuters (Tom Arnold and Alexander Cornwell): “Sharp swings in global financial markets in the past few days are not worrying since economic growth is strong but reforms are still needed to avert future crises, the managing director of the International Monetary Fund said… ‘I‘m reasonably optimistic because of the landscape we have at the moment. But we cannot sit back and wait for growth to continue as normal,’ she said…”

Fixed-Income Bubble Watch:'

February 13 – Wall Street Journal (Daniel Kruger and Michael S. Derby): “Bond investors are grappling with concerns that the U.S. government’s decisions to cut taxes and increase spending are stoking an economy that doesn’t need a boost, at the expense of long-term financial health. Selling in government bonds that began after the passage of tax cuts and accelerated amid fears of a pickup in inflation has darkened investors’ outlook in recent weeks. Even as the government boosts its borrowing, the Federal Reserve has stepped away from bond purchases and is now shrinking its holdings, raising worries about the appetite from private investors who will need to make up the difference. Because the 10-year Treasury note is a bedrock of global financial markets, rising yields… can lift borrowing costs, affecting everything from state and local governments to mortgages, credit cards, and corporate loans.”

February 12 – Bloomberg (Netty Idayu Ismail): “Treasury 10-year yields will rise to as high as 3.5% in the next six months as the market prices in a steeper pace of Federal Reserve tightening, according to Goldman Sachs Asset Management. The U.S. central bank will probably raise interest rates four times this year, defying the consensus for around three, said Philip Moffitt, Asia-Pacific head of fixed income…, which oversees more than $1 trillion. Yields will also increase as the Fed trims the holdings of Treasuries it purchased through quantitative easing, he said. ‘As QE gets tapered through this year and into next year, we’ve got a big swing in the supply duration coming,’ Moffitt said… ‘It’s going to put upward pressure on yields. I would think that 3.5% is not a very brave forecast.’”

February 15 – Bloomberg (Sid Verma): “As stocks boogied to the risk-on beat Wednesday, investors in the world’s third-largest fixed-income exchange-traded fund left the party at a frenetic pace. The iShares iBoxx $ Investment Grade Corporate Bond exchange-traded fund (LQD) was hit by a record $921 million outflow, the largest daily redemption since its 2002 inception… At 2.7%, it represents the largest post-crisis withdrawal as a share of total assets at the start of the session for the high-grade, dollar-denominated fund. It now manages $33 billion.”

February 13 – CNBC (Jeff Cox): “Fund managers have sliced their bond allocations to the lowest level in 20 years as fears grow that the sector poses the biggest threat to markets. Along with reducing their fixed income exposure, 60% of professional investors also say inflation and troubles overall in the bond market pose the biggest threat of a ‘cross-asset crash,’ according to the February Bank of America Merrill Lynch Fund Manager Survey. Respondents say they've reduced their bond portfolios to a net 69% underweight, the lowest since the survey began two decades ago.”

February 14 – Bloomberg (Danielle Moran): “Bankers say bad loans are made in good times, and the $3.8 trillion municipal-bond market may be no exception. High demand from investors, a dwindling supply of new deals, and historically low yield penalties on the riskiest bonds has created an borrower’s market, Municipal Market Analytics analysts Matt Fabian and Lisa Washburn wrote… This atmosphere has produced a rise in issuance in sectors most ‘prone to impairment,’ they said. ‘Over recent years the mix of defaults has become more diversified than it was previously,’ Washburn wrote. Before the 2008 credit crisis, nearly all defaults were concentrated in the healthcare and housing sectors. Now that trend is expanding into utility districts and tax-based issues, typically known as safe sectors, according to the firm.”

Europe Watch:

February 14 – Reuters (Jan Strupczewski): “Euro zone industrial production jumped more than expected in December…, underlining the fastest economic growth rate in a decade that economists expect to continue in 2018. Eurostat said industrial production in the 19 countries sharing the euro rose 0.4% month-on-month for a 5.2% year-on-year gain.”

February 13 – Financial Times (Robert Smith): “When European bond investors tired of private equity firms and the law firms they employ watering down key protections in junk-rated debt, they turned to the Association for Financial Markets in Europe. Influential asset managers such as AllianceBernstein and Schroders wrote a public letter to the board of AFME’s high-yield division — the closest thing the $400bn European junk bond market has to an industry trade body — expressing their dismay. These investor members of AFME took particular aim at the deteriorating quality of covenants — important clauses that restrict companies from taking reckless actions such as raising too much debt. That was in 2015. Today the quality of these covenants… is even worse. Asset managers such as pension funds are worried that whittling away these safeguards will leave them more exposed to losses when the credit cycle turns.”

Japan Watch:

February 14 – Financial Times (Robin Harding): “The yen’s surge to ¥106.5 against the dollar — a 15-month high — does not require market intervention, said Japan’s finance minister, as nerves grow about the currency’s sharp appreciation this year. Speaking to the budget committee of the Diet’s lower house, Taro Aso said the ‘yen isn’t rising or falling abruptly’ in a way that would justify the finance ministry stepping in and selling the currency. Against a backdrop of strong stock markets and solid global growth, Mr Aso’s remarks suggest the finance ministry does not yet fear a hit to Japan’s economy from the rising currency. His words may encourage markets to push the yen higher.”

February 13 – Financial Times (Hudson Lockett): “Japan’s economy has recorded eight consecutive quarters of economic growth — its longest streak for 28 years — despite the pace of expansion slowing in the final three months of 2017. A preliminary reading on gross domestic product from the Cabinet Office reported annualised growth of 0.5% in the fourth quarter, falling from a pace of 2.5% in the third quarter… However, consumption and business investment were both strong, suggesting that Japan’s economic cycle was not on the wane, with robust expansion set to continue in 2018. The eight quarters of growth mark Japan’s longest streak since a 12-quarter stretch that ended in 1989.”

EM Bubble Watch:

February 13 – Financial Times (Robert Smith): “Should investors worry about debt in emerging markets? The past week’s global market sell-off, and the rise in US interest rates that lies behind it, suggest they should at least keep a very close eye… One of the selling points of EMs during the rally in their stocks and bonds over the past two years has been the improvement in their macroeconomic fundamentals… Indeed, there is much less EM debt today than there was in the crisis years of the 1980s and 1990s. But since the global financial crisis of 2008-09, EM debts have been on the rise again. In dollar terms, in the IIF’s 21 countries, they quintupled from $12tn in March 2005 to $60tn in September last year. In relation to gross domestic product, they rose from 146% to 217%. Significantly, as the chart shows, the amount of debt owed in foreign currencies has also risen over the same period, both in absolute terms and as a share of GDP.”

Leveraged Speculation Watch:

February 13 – Bloomberg (Luzi-Ann Javier): “Billionaire hedge fund manager Ray Dalio boosted his holdings in the two largest gold-backed ETFs last quarter before prices of the metal capped the biggest annual gain in seven years. As of the end of December, Dalio’s Bridgewater Associates, the world’s biggest hedge fund, raised its stake in SPDR Gold Shares, its fifth-largest holding, by 14,091 shares to 3.91 million shares…”

Geopolitical Watch:

February 12 – Bloomberg (Gregory White): “The war in Syria is threatening to embroil the major powers in direct conflict. Russian President Vladimir Putin may have declared victory in his Syrian campaign two months ago, but… a strike by U.S.-led coalition forces in the east of Syria last week killed as many as 200 troops working for Russian military contractors. The raid was likely the first such deadly conflict between the former Cold War rivals since the Vietnam War, according to Russian experts. Both sides so far have tried to keep the details secret to avoid escalating an already volatile situation. Just days later, Israel downed an Iranian drone and struck targets in Syria, raising the ante in its efforts to drive forces backed by Tehran away from its border. Following those strikes, Putin urged ‘avoiding any steps that could lead to a new round of confrontation.’”

February 11 – Wall Street Journal (Rory Jones): “The loss of an Israeli military jet to Syrian fire over the weekend has raised the chances of a more forceful response from Israel to deter Iranian military expansion across its border, which could open up another front line in war-torn Syria. The clash began Saturday morning after Israel said it intercepted an Iranian drone that had infiltrated its airspace from Syria. Israel responded that day with airstrikes on Syrian military positions, and Syria shot down one of the Israeli warplanes, which crashed in Israeli territory. Israel then carried out more-extensive airstrikes on Saturday deep inside Syria targeting what its military said were Syrian and Iranian military positions.”

February 15 – Wall Street Journal (Yaroslav Trofimov): “Here’s what happened in Syria over the past week or so. Try to make out who’s whose friend—and who’s whose foe. The Russian-backed Syrian regime gave free passage through its territory to American-backed Kurdish militias so they could fight against America’s NATO ally Turkey. The Syrian regime at the same time attacked these American-backed Kurdish militias in another part of the country, triggering U.S. strikes that killed more than 100 Syrian troops and a significant number of Russian military contractors. In yet another part of Syria, Turkey threatened to attack American troops embedded with these Kurdish forces, prompting a counterwarning of an American military response.”

February 11 – Reuters (Parisa Hafezi): “Hundreds of thousands of Iranians rallied on Sunday to mark the anniversary of Iran’s 1979 Islamic revolution, denouncing the United States and Israel as oppressors. President Hassan Rouhani, addressing flag-waving crowds on central Tehran’s Azadi (Freedom) Square, made no specific reference to Israel’s air strikes in Syria on Saturday which it said were aimed at air defense and Iranian targets. But he told the crowd: ‘They (U.S. and Israel) wanted to create tension in the region ... they wanted to divide Iraq, Syria ... They wanted to create long-term chaos in Lebanon but ... but with our help their policies failed.’”

February 6 – Wall Street Journal (Spencer Jakab): “Only very rarely has a trade gone from being so good to being so bad so quickly. Among the most profitable trades during the bull market has been to short volatility, essentially betting the market would get calmer and stay calm. An exchange-traded instrument, the VelocityShares Daily Inverse VIX Short-Term exchange-traded note, grew to $2 billion by harnessing futures on the Cboe Volatility Index. The note, with the symbol XIV, had a 46% compound annual return from its inception in 2010 to two weeks ago. Late on Monday, though, the combined value of the note fell 95% to less than $15 million as trading was halted early Tuesday… The product contained the seeds of its own destruction. By selling short futures on the Cboe Volatility Index, or VIX, it profited in two ways in the recent market calm. It took advantage of the typical ‘contango’ present in the market—longer-dated futures tended to be higher-priced than VIX itself and fall in value. Constantly rolling over the position to sell more distant futures was a moneymaker. Another was simply profiting from volatility falling to near record lows.”

The collapse of two Bear Stearns structured Credit funds in July 2007 marked a critical (mortgage finance) Bubble inflection point. These funds were highly leveraged in (mainly “AAA”) collateralized debt obligations (CDOs), as well as being enterprising operators in Credit default swaps (CDS). It was essentially a leveraged play on the relatively stable spread between subprime mortgage yields and market funding costs. It all worked splendidly, so long as stability was maintained in the subprime mortgage marketplace. This strategy blew up spectacularly when confidence in subprime began to wane (rising delinquencies) and lenders to Bear Stearns (and others) turned skittish. Liquidity in subprime-related securities evaporated almost overnight.

About everyone downplayed the relevance of subprime. It was a “small” insignificant market. U.S. economic fundamentals were robust, while cracks had yet to become visible in prime mortgages or U.S. housing more generally. Indeed, the decline in market yields heading into 2008 worked for a while to support home and asset prices, including an equities market rally and a new record high for the S&P500 in October 2007.

Missing in the analysis was the critical role structured finance had assumed throughout the mortgage marketplace, especially late in the cycle. CBBs during the mortgage financial Bubble period focused often on “The Moneyness of Credit” and “Wall Street Alchemy.” Literally Trillions of risky mortgages were being transformed into perceived safe and liquid “AAA” securities. Sophisticated risk intermediation fundamentally altered demand dynamics for high-risk loans.

Perceived money-like subprime securities enjoyed virtually insatiable demand in the marketplace, providing prized high-yield fodder for a late-cycle manic episode of leveraged speculation. And so long as sophisticated risk intermediation was running hot, there remained readily available inexpensive mortgage Credit to sustain home price inflation and system liquidity more generally. It became of case of the greater the quantity of risky loans intermediated through Wall Street’s sophisticated structures - the lower the cost and the greater the liquidity in the booming market for mortgage risk “insurance”. With readily available cheap insurance, why not aggressively speculate and leverage?

Finance flooded into structured products, with 2006 seeing a staggering $1.0 TN of subprime-related CDO issuance. The insatiable demand for these higher-yielding instruments ensured even the weakest Credits (devoid of down-payments) would bid up home prices across the country. And years of housing inflation ensured risk model forecasts of minimal future loan losses – and “AAA” ratings galore. In a critical Bubble “Terminal Phase” dynamic, Credit Availability loosened dramatically as borrowing costs declined – ensuring final precarious “blow-offs” in Credit, home inflation and asset prices more generally. In the end, the parabolic expansion of systemic risk created untenable demands on the financial system and risk intermediation, in particular.

Underpinning mortgage finance Bubble Dynamics was the deeply held market view that Washington (the Fed, Treasury, GSEs and Congress) would never tolerate a housing bust. This perception ensured the GSEs would continue to insure mortgages and borrow at risk-free rates despite the reality that they were effectively insolvent. It was this deeply embedded perception and the booming prime mortgage marketplace that over time cultivated all the nonsense that unfolded in subprime structured finance. The Washington backstop ensured that unlimited cheap Credit remained readily available even after years of mounting excess. The resulting “Moneyness of Credit” nurtured major pricing distortions in Trillions of securities.

For nine long years now, CBB analysis has posited “the global government finance Bubble,” “The Moneyness of Risk Assets” and the “Granddaddy of all Bubbles” theses. I believe the Bubble has likely been pierced. The spectacular blowup of all these “short vol” products is a replay of subprime in the summer of 2007 - just so much bigger and consequential. The “insurance” marketplace has badly dislocated, concluding for now the environment of readily available cheap market protection.

Structured finance was instrumental in ensuring the marginal subprime buyer could access the means to keep the Bubble inflating, even in the face of inflated home prices increasingly beyond affordability. These days, all these structured volatility products have been key to enormous pools of “money” chasing inflated securities prices increasingly detached from reality.

A Paradox of Dysfunctional Contemporary Finance: The higher home prices inflated (and the greater systemic risk) the cheaper it became to “insure” mortgage Credit risk. More recently, the higher stock prices have inflated (and the greater systemic risk), the cheaper it has been to “insure” equities market risk. These highly distorted “insurance” markets became instrumental in attracting the marginal source of finance fueling late-stage “Terminal Excess” throughout the risk markets.

Variations of these “short vol” strategies have essentially been writing flood insurance during a prolonged drought. Key to it all, global central bankers for the past nine years have been intently controlling the weather.

In the mortgage finance Bubble post-mortem, the Fed convinced itself that bad bankers and weak regulation of mortgage lending were the villains. In reality, the overarching issue was found within the financial markets: confidence that policymakers were backstopping the markets fomented price distortions, self-reinforcing speculative excess and untenable leverage. Failing to learn this critical lesson from the Bubble period, radical post-crisis monetary policymaking fostered the perception that equities and corporate Credit were safe and liquid money-like instruments (“Moneyness of Risk Assets”), in the process profoundly transforming market demand, price and speculative dynamics.

Importantly, activist reflationary policymaking ensures that speculative leveraging becomes a prevailing source of liquidity throughout the markets and in the overall economy. When de-risking/de-leveraging dynamics took hold in 2008, a deeply maladjusted system immediately became starved of liquidity. Dislocation (spike in pricing and illiquidity) in the “insurance” markets – subprime in 2007 and equities in early-2018 – marked a critical juncture in risk-taking, leveraging and overall system liquidity.

February 7 – Bloomberg (Dani Burger): “For a fledgling asset class whose idiosyncrasies are understood by few, there sure is a lot of money swirling around in volatility trades. Investment strategies and products married to market swings were thrust front and center by the worst market meltdown in seven years, in which the Cboe Volatility Index surged to its highest level since 2015. VIX-related securities were halted, volatility-targeting quants blamed, and options trading in benchmarks for turbulence ballooned. Too big to ignore, it’s an asset class in its own right, with the might to push around the broader market. Getting a grip on it has confounded strategists and managers alike… There are two categories of securities linked to price turbulence, roughly speaking: ones tied to the VIX directly, and others that take their cue from the volatility of individual stocks. Altogether, estimates for the space are anywhere from $1.5 trillion to $2 trillion. Beyond that is the options market, which itself is an implicit bet on swings in shares.”

Things turn crazy near the end of major Bubbles – and The Bigger the Crazier: One Trillion of subprime CDO issuance (2006) and today’s “anywhere from $1.5 trillion to $2 trillion” of volatility trades is some real financial insanity. The Fed’s strategy has been to aggressively reflate and entrust “macro-prudential” regulation for safeguarding financial stability. Why has there been zero effort to regulate the proliferation of highly leveraged “short vol” products?

It was an extraordinary week that offered overwhelming support for the Bubble thesis. In particular, the risk market “insurance” marketplace was in fact an accident waiting to happen. Moreover, today’s Bubble is very much a global phenomenon.

U.S. equities mounted a decent Friday afternoon rally, with the S&P500 (reversing an almost 2% inter-day decline) ending the session with a gain of 1.5%. Perhaps the U.S. market recovery will spark a Monday reversal in Asia and Europe. With option expiration next Friday, it would not be uncharacteristic for a market rally to pressure recent buyers of put protection into expiration. It also wouldn’t be all too surprising to see some players ready to sell an elevated VIX with the first semblance of stability. It’s worked so many times in the past.

It was an extraordinary week in several respects: the VIX traded as high as 50, intense selling of equities across the globe and a meaningful widening of high-yield corporate Credit spreads. Considering the spike in equities volatility, the corporate debt market held together reasonably well (certainly bolstered by ongoing large ETF inflows). Investment-grade CDS did jump to five-month highs. Junk bond funds suffered outflows of $2.743 billion, helping along with the VIX spike to spark the biggest jump in high-yield CDS in about a year. Global bank CDS moved higher this week (from compressed levels), led not surprisingly by Deutsche Bank and some of the other major European lenders. The GSCI Commodities index sank 6.1%, with crude down $6.25, silver falling 3.4% and copper sinking 4.8%.

Curiously, the Treasury market is struggling to live up to its safe haven billing. Notably, in all the market mayhem, 10-year Treasury yields actually added a basis point to 2.85% (up 45bps y-t-d). Long-bond yields rose seven bps to 3.16%. German bund yields gave up only two bps this week, with yields still up 32 bps y-t-d. So not only did the cost of market “insurance” hedges spike higher, Treasury holdings this week did not provide their traditional hedging benefit. This made it an especially rough week for “risk parity” and other leveraged strategies that have relied on a Treasury allocation to help mitigate portfolio risk.

The risk versus reward calculus has rather quickly deteriorated for risk-taking and leveraging. Markets have turned much more volatile and uncertain – equities, fixed-income, currencies and commodities. The cost of market “insurance” has spiked, the Treasury market safe haven attribute has been diminished and various market correlations have increased, certainly including global equities markets. “Risk Off” has made a rather dramatic reappearance. How much leverage is lurking out there in global securities and derivatives markets?

Next week is tricky. I would generally expect at least an attempt at a decent rally prior to options expiration. But at the same time, my sense is that market players are especially poorly positioned for the unfolding “Risk Off” backdrop. A break of this week’s trading lows would likely see another leg down in the unfolding bear market. And with derivatives markets already stressed, major outflows from the ETF complex would be challenging for less than liquid markets to accommodate.

It took about 15 months from the collapse of the Bear Stearns structured Credit funds in 2007 to the market crisis in the fall of 2008. Many still believe that crisis was completely avoidable had the Fed intervened to save Lehman. Yet it was much more of an issue of Trillions of dollars of mispriced securities, dysfunctional risk intermediation, enormous accumulated financial and economic risks, and the inevitability of the financial system’s inability to sustain the necessary quantities of new Credit to keep the Bubble inflating (following parabolic “terminal” excesses).

Similar issues overhang financial systems and economies today, but on an unprecedented global scale. The Treasury market is a glaring difference between 2018 and 2007. After trading as high as 5.30% in June 2007, 10-year Treasury yields sank to 3.84% by November. Fed funds were at 5.25% throughout the summer of 2007, with the Fed slashing rates 50 bps on September 18th and another 50 bps before year-end. I would posit that it stretched out five quarters from “inflection point” to crisis because the Fed back in 2007 still had significant room to push bond and MBS yields lower (prices higher). The Bernanke Fed enjoyed flexibility that the Powell Fed does not. The Treasury ran a $161 billion deficit in fiscal-year 2007.

Things Just Got Too Crazy – completely out of hand. The equities melt-up, the crypto currencies, the technology/biotech mania, M&A, leveraged loans, the return of booming structured finance and the collapse in risk premiums throughout global Credit markets. The Dow is going to a million – along with Bitcoin. Trillions of unending ETF flows. The VIX down to 8.56. Caution to the wind – epically. China Credit.

With another $2.7 TN of QE in 2017, central bankers pushed the envelope too far. And, importantly, Washington (and governments around the world) just went nuts with the view that spending is wonderful and deficits don’t matter. Too many years of central bank-induced over-liquefied markets incentivized excess, from Wall Street to Silicon Valley to Washington to Beijing to Tokyo and Frankfurt. Markets at home and abroad completely failed as mechanisms to discipline, to self-adjust and to correct.

The U.S. dollar index rallied 1.4% to 90.442 (down 1.8% y-o-y). For the week on the upside, the Japanese yen increased 1.3% and the South African rand gained 0.8%. For the week on the downside, the Norwegian krone declined 2.9%, the Brazilian real 2.5%, the Swedish krona 2.2%, the British pound 2.1%, the euro 1.7%, the Australian dollar 1.5%, the Canadian dollar 1.2%, the South Korean won 1.1%, the Swiss franc 0.8%, the New Zealand dollar 0.6%, the Singapore dollar 0.6% and the Mexican peso 0.6%. The Chinese renminbi was little changed versus the dollar this week (up 3.23% y-t-d).

Commodities Watch:

February 6 – Bloomberg (Ranjeetha Pakiam and Daniela Wei): “China’s growing throng of affluent consumers is driving a rebound in demand for gold rings, bracelets and necklaces as a property boom and high stock market valuations boost wealth in the largest bullion market. ‘Things are much more positive than they were this time last year,’ and the jewelry market has bottomed out after three years of declines, said Nikos Kavalis, London-based director of research firm Metals Focus Ltd… The nation’s demand for gold jewelry climbed 10% last year to almost 700 metric tons as the wealthy increased purchases and consumption improved in second and third-tier cities…”

February 6 – CNBC (Tae Kim): “A key measure of market volatility is gyrating wildly Tuesday after a triple-digit percentage move the previous day. The CBOE Volatility Index, or VIX, is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. It's sometimes called the ‘fear gauge.’ Volatility refers to the amount of uncertainty in the size (and direction) of changes in a security's value and is typically measured by the deviation of returns. The VIX surged by 115.6% on Monday to 37.32. It rose briefly early Tuesday to over 50, the highest level since Aug 2015. The VIX then dropped to 22.42, rose to over 45, before fading to roughly 35.”

February 5 – Bloomberg (Sarah Ponczek, Elena Popina, and Lu Wang): “Risk parity funds. Volatility-targeting programs. Statistical arbitrage. Sometimes the U.S. stock market seems like a giant science project, one that can quickly turn hazardous for its human inhabitants. You didn’t need an engineering degree to tell something was amiss Monday. While it’s impossible to say for sure what was at work when the Dow Jones Industrial Average fell as much as 1,597 points, the worst part of the downdraft felt to many like the machines run amok. For 15 harrowing minutes just after 3 p.m. in New York a deluge of sell orders came so fast that it seemed like nothing breathing could’ve been responsible.”

February 6 – Bloomberg (Elena Popina and Sarah Ponczek): “Does the chaos embroiling equity markets have an obvious precedent that can guide investors on how it plays out? While the Crash of ’87 and 2008 financial crisis have been name checked, a more relevant example may be 1998, the first test of the internet bubble. It was a period in the market that has some eerie parallels to today. Stocks were in the eighth year of a giant bull run that had relentlessly expanded valuations. The Federal Reserve had just begun a tightening cycle. And behind the scenes, sophisticated speculators were getting into trouble. While drama played out rapidly, its depth may be a lesson for investors wondering how bad things can get in such an environment. The S&P 500 Index violently plunged 19% in a matter of weeks, from a high on July 17, 1998, through the last day of August. Yet, the decline was all but forgotten two months later.”

February 5 – Bloomberg (Lu Wang): “The plunge in U.S. stocks just after 3 p.m. went beyond a normal reaction to economic circumstances and had elements of a liquidity-driven selloff like the one that landed on markets in May 2010, an analyst said. ‘We can officially call the last 20ish minutes a flash crash,’ said Dennis Debusschere, head of portfolio strategy at Evercore ISI. Loosely defined, the term ‘flash crash’ denotes a phenomenon in electronic markets in which the withdrawal of stock orders rapidly exacerbates price declines.”

February 5 – Market Watch (Mark DeCambre): “Tightly wound correlations between assets have prevailed in recent trade on Wall Street, and they are at their highest level since December 2012, according to Deutsche Bank’s chief strategist, Binky Chadha. Chadha says closely bound correlations, meaning that a move in one directly influences a move in another, reflects market extremes as investors flock into certain assets. The Deutsche Bank analyst says cross-asset correlations are at 90%. A reading of 100% represents perfect correlation, where assets tend to move in the same direction at the same time.”

Trump Administration Watch:

February 5 – Reuters (James Oliphant): “With stock markets declining again, the White House… said the fundamentals of the U.S. economy are strong. ‘Markets fluctuate, but the fundamentals of this economy are very strong and they are headed in the right direction,’ White House spokesman Raj Shah told reporters on Air Force One…”

February 7 – CNBC (Yian Mui): “Republicans are learning that the easiest way to solve a problem in Washington is with money. Lots of it. Back in full control of the levers of government, the party that long espoused fiscal prudence is paving the way for substantial new federal spending that — combined with Republicans' sweeping tax cut — is projected to send America's deficit to record highs. The Treasury Department says it will need to borrow more than $1 trillion in each of the next two fiscal years… That figure doesn't factor in the reported $300 billion in increased spending that Senate leadership is negotiating as part of a two-year deal to fund the government. Washington will also need to raise the national debt ceiling before the end of next month.”

February 7 – Wall Street Journal (Nick Timiraos): “The spending deal reached by congressional leaders Wednesday marks an end to the budget austerity congressional Republicans sought to advance in Washington in 2011. Back then, Republicans negotiated a series of automatic curbs on defense and domestic discretionary spending with President Barack Obama that, along with a growing economy and ultralow interest rates, helped bring down deficits. Now, party leaders have made a U-turn. Last December, President Donald Trump signed into law tax cuts of $1.5 trillion over a decade, and congressional leaders Wednesday agreed with Democrats to boost federal spending by nearly $300 billion over two years from what was already in train.”

February 6 – Financial Times (Shawn Donnan): “The US trade deficit grew 12.1% to its highest level since 2008 in Donald Trump’s first year in office, suggesting that the president is making little headway in his promise to rewrite America’s trading relationship with the world. Economists say the surge in the US goods and services deficit to $566bn last year was mostly caused by an improving domestic economy and rising demand from consumers and companies for imported goods. US exports grew 5.4% to $2.3tn, their second-highest level on record, while imports reached a record $2.9tn in 2017.”

February 3 – Washington Post (Heather Long): “It was another crazy news week, so it's understandable if you missed a small but important announcement from the Treasury Department: The federal government is on track to borrow nearly $1 trillion this fiscal year… That's almost double what the government borrowed in fiscal year 2017. Here are the exact figures: The U.S. Treasury expects to borrow $955 billion this fiscal year… It's the highest amount of borrowing in six years, and a big jump from the $519 billion the federal government borrowed last year. Treasury mainly attributed the increase to the ‘fiscal outlook.’ The Congressional Budget Office was more blunt. In a report this week, the CBO said tax receipts are going to be lower because of the new tax law.”

February 9 – Reuters (Richard Cowan and James Oliphant): “The budget deal passed by U.S lawmakers early on Friday will alleviate the spending fights that marked President Donald Trump’s first year in office, but sets the stage for a battle over immigration and who is to blame for exploding deficits ahead of November’s congressional elections. In the short term, reducing the risk of government shutdowns could help Trump and Republicans by conveying a greater sense of stability. But Democrats are gearing up to use rising budget deficits under Trump and what they see as draconian immigration policies to hammer Republicans in the midterm elections when they will seek to take back control of Congress.”

February 6 – Wall Street Journal (Jacob M. Schlesinger): “China is showing a willingness to push back against mounting trade pressure from the Trump administration, filing challenges to new U.S. tariffs on solar panels and washing machines at the World Trade Organization. The petitions submitted to the global commerce arbiter… argue that the tariffs ‘are not consistent’ with international rules, and seek compensation from Washington. The petitions follow an announcement on Sunday by the Chinese Commerce Ministry that it was investigating American exporters of sorghum for allegedly ‘dumping’ the grain below cost, aided by improper U.S. government subsidies, into the Chinese market. The probe could result in duties being imposed to block the U.S. product. The Trump administration has been debating adopting a tougher trade policy against China, possibly including broad tariffs and investment restrictions. The measures are being considered as part of a probe into widespread complaints that the Chinese government forces U.S. companies to turn over valuable intellectual property as the price for entering their market…”

February 9 – Reuters (Ben Blanchard and Jess Macy Yu): “A U.S. bill that encourages reciprocal visits by U.S. and Taiwanese government officials threatens stability in the Taiwan Strait and the United States must withdraw it, China’s Foreign Ministry said… The bill passed the U.S. Senate Committee on Foreign Relations this week and will now move to the Senate. Beijing considers democratic Taiwan to be a wayward province and integral part of ‘one China’, ineligible for state-to-state relations, and has never renounced the use of force to bring the island under its control.”

U.S. Bubble Watch:

February 9 – CNBC (Natasha Turak): “U.S. stock funds saw a record $23.9 billion withdrawn by investors in the last week…, as the turmoil in global stock markets saw traders shun equities in favor of perceived safe havens. Exchange-traded fund (ETF) outflows alone constituted the bulk of withdrawals, at $21 billion, while mutual fund outflows made up $3 billion of withdrawals, according to data from Thomson Reuters' Lipper unit.”

February 7 – Bloomberg (Sid Verma and Dani Burger): “The global market maelstrom spurred money managers to yank a record $17.4 billion from the mighty SPDR S&P 500 ETF over the past four trading sessions. The $8 billion removed on Tuesday alone was the third-largest daily withdrawal in the post-crisis era. The last time redemptions were close to matching this frenetic pace? In late 2007, when cracks in U.S. equities began to show before the global financial crisis unfolded.”

February 6 – Bloomberg (Sho Chandra): “The U.S. trade deficit widened to the biggest monthly and annual levels since the last recession, underscoring the inherent friction in President Donald Trump’s goal of narrowing the gap while enjoying faster economic growth. The deficit increased 5.3% in December to a larger-than- expected $53.1 billion, the widest since October 2008, as imports outpaced exports… For all of 2017, the goods-and-services gap grew 12% to $566 billion, the biggest since 2008.”

February 9 – Wall Street Journal (Andrew Tangel, Harriet Torry and Heather Haddon): “U.S. manufacturers and food companies are grappling with rising material and ingredient costs on top of pressure from higher wages—a potential double whammy that could force them to raise prices or accept lower profit margins. ‘We just see the inflation trends creeping in on many parts of our value chain,’ Whirlpool Corp. Chief Executive Marc Bitzer told analysts… The… appliance giant projected that additional raw-material costs, driven by rising prices of steel and resin, would shave as much as $250 million off its profit this year.”

February 7 – Bloomberg (Elizabeth Campbell): “As Illinois prepares for Governor Bruce Rauner to unveil a proposed budget next week, the worst-rated state is already awash in billions of dollars of red ink, according to Comptroller Susana Mendoza. Lawmakers and Rauner will have to contend with deficit spending in the current fiscal year as they work to craft a spending plan for next year… $2.3 billion of deficit spending in the form of unappropriated liabilities held at state agencies as of Dec. 31. $8.4 billion of unpaid bills as of Feb. 7. $1.03 billion of late-payment interest fees incurred as of Dec. 31, 2017… $1.7 billion general fund deficit.”

Federal Reserve Watch:

February 8 – CNBC (Jeff Cox): “New Federal Reserve Chairman Jerome Powell may have a few surprises in store for the market, judging by past statements he has made behind the central bank's closed doors and some whispers going around Wall Street. Powell took the helm of the Fed on Monday… While there seems little fear that Powell will be hostile to markets, assuming that he is going to be a carbon copy acolyte of Yellen could be a mistake. There are a few potential points of contrast. One is in comments Powell made during Federal Open Market Committee meetings in 2012… At several meetings then he expressed serious reservations about the direction of monetary policy, questioning the efficiency of the Fed's low-interest-rate money-printing philosophy at the time… ‘I think we are actually at a point of encouraging risk-taking, and that should give us pause,’ Powell said at the October 2012 FOMC meeting…”

February 5 – Bloomberg (Craig Torres and Christopher Condon): “Federal Reserve Chairman Jerome Powell was met with a surging bout of market volatility in his first day in office, as stocks fell and long-term interest rates plunged in response. The 4.1% rout in the S&P 500 index on Monday, the steepest decline since 2011, poses more questions than answers so far for Powell and his team.”

February 7 – Wall Street Journal (Justin Lahart): “Investors think the Federal Reserve is waiting with a net below the stock market, and chances are they are right. The only problem is that the net is far below where stocks are now. The recent sharp drop in stocks began because investors were worried the Fed might raise rates faster than they had thought. When the selloff got worse, there was a view that the Fed might not raise very much because of the volatile market. Interest-rate futures now suggest investors are split over whether the central bank will raise rates three times this year, as Fed policymakers have projected, or just twice. Contrast that with early Friday, when the futures started pricing in the possibility of a fourth rate hike.”

February 7 – Bloomberg (Jeanna Smialek): “Federal Reserve Bank of San Francisco President John Williams said he isn’t altering his view on the U.S. economy or preference for a continued gradual rate hike path after several days of volatile markets. ‘It’s not about the market themselves, it’s about -- basically, what are they telling us about the likely path of the economy?’ Williams told reporters… ‘At this point, I don’t see any of the movements in asset prices of late to fundamentally change my view of the economy. I think the economy is on a very solid growth path. In fact, I think some of the market reaction is to the fact that the economy is doing well.”

February 8 – Reuters (Balazs Koranyi): “The U.S. Federal Reserve is likely to continue removing policy accommodation gradually and could hike rates three times this year, Dallas Fed President Robert S. Kaplan told a business conference in Frankfurt… Kaplan said recent market volatility in itself was not enough to change his base scenario, although he was ‘highly vigilant’ about the turbulence and would study whether it has any effect on the real economy. ‘At this point, I don’t see this market adjustment spilling over into financial conditions - but I’ll be watching carefully,’ Kaplan… told reporters... ‘My base case is the same.’”

February 2 – CNBC (Jeff Cox): “Janet Yellen leaves the Federal Reserve with the economy clicking, the stock market humming and the central bank on a clear path away from the emergency policies it put into place to help rescue the U.S. from the deep throes of the financial crisis. Yet her grade as head of the Fed is a decided ‘incomplete.’ Yes, by any typical standard of performance Yellen would be considered an unqualified success. She and her colleagues enacted programs and policies that have brought the economy and financial system back from the brink. She is almost universally respected on Wall Street, even if she remains a bit of an enigma on Main Street. But no one knows yet what the future ramifications will be of the extreme measures the Fed took under her watch and that of her immediate predecessor, Ben Bernanke.”

February 5 – Bloomberg (Ros Krasny and Scott Lanman): “Outgoing Federal Reserve Chair Janet Yellen said U.S. stocks and commercial real estate prices are elevated but stopped short of saying those markets are in a bubble. ‘Well, I don’t want to say too high. But I do want to say high,’ Yellen said on CBS’s “Sunday Morning”… ‘Price-earnings ratios are near the high end of their historical ranges.’ Commercial real estate prices are now ‘quite high relative to rents,’ Yellen said. ‘Now, is that a bubble or is it too high? And there it’s very hard to tell. But it is a source of some concern that asset valuations are so high.’”

China Watch:

February 9 – Reuters (John Ruwitch and Samuel Shen): “Chinese stocks suffered their worst day in almost two years on Friday, with blue-chip led carnage dragging the markets into correction territory… The benchmark Shanghai Composite Index tumbled 4.0% and the blue-chip CSI300 ended the day down 4.3%. At one point, both were down more than 6%. It was the biggest single-day dive for the two since February 2016, when the fallout from a botched attempt to introduce a circuit-breaker mechanism after a market meltdown was still rattling investors. Hong Kong shares, meanwhile, slumped to their biggest weekly loss since the global financial crisis. ‘It’s bulls killing bulls’, said hedge fund manager Gu Weiyong about the stampede out of stocks…”

February 7 – Bloomberg: “Chinese regulators appear to be winning their war against risk in one of the more dangerous corners of the country’s shadow banking industry -- the so-called wealth management products that banks buy from each other in a search for easy profits. Interbank holdings of WMPs more than halved last year, to 3.25 trillion yuan ($520 million) in December from 6.65 trillion yuan a year earlier… That suggests higher interest rates and increased scrutiny by regulators are deterring Chinese banks from their previous practice of using cheap interbank borrowing to invest in each others’ higher-yielding WMPs… The CBRC and other regulators are working closely in an unprecedented campaign to curb the $16 trillion shadow banking industry, of which WMPs issued by banks are the largest component. Another risky area that is contracting rapidly is some $3.8 trillion of so-called trust products, which have been a popular way for debt-ridden property developers and local governments to raise funds.”

February 8 – Bloomberg (Sofia Horta E Costa): “Investors got a stark reminder of how fast their bets can turn in China, where the most bullish trades are falling apart. The country’s currency was their latest favorite to succumb to a rout that has roiled financial markets around the world this week, losing as much as 1.2% on Thursday for the biggest decline since the aftermath of its 2015 shock devaluation. That follows a selloff in large caps and banks that has wiped out about $660 billion from the value of Chinese equities. Traders are running out of places to hide in a nation where market declines have a habit of snowballing. Government bonds are offering little in the way of comfort, and even commodities are feeling the squeeze. Making matters worse is the prospect of seasonally tighter liquidity ahead of the Lunar New Year holiday…”

February 7 – Bloomberg: “China’s overseas shipments held up despite trade tensions with the U.S., while import growth surged reflecting calendar effects and higher commodity prices. Exports rose 11.1% in January in dollar terms from a year earlier while imports increased 36.9%, leaving a $20.34 billion trade surplus.”

February 5 – Reuters (Stella Qiu and Ryan Woo): “China’s services sector got off to a flying start in 2018, expanding at its fastest pace in almost six years as new orders surged and companies rushed to hire more staff… Economists also attributed the robust strength in services in January to better access to bank loans at the start of the year and solid demand before the long Lunar New Year celebrations, which fall in mid-February.”

February 9 – Bloomberg (Sungwoo Park): “China, the world’s biggest oil buyer, is opening a domestic market to trade futures contracts. It’s been planning one for years, only to encounter delays. The Shanghai International Energy Exchange, a unit of Shanghai Futures Exchange, will be known by the acronym INE and will allow Chinese buyers to lock in oil prices and pay in local currency. Also, foreign traders will be allowed to invest -- a first for China’s commodities markets -- because the exchange is registered in Shanghai’s free trade zone. There are implications for the U.S. dollar’s well-established role as the global currency of the oil market.”

Central Bank Watch:

February 8 – Bloomberg (Jill Ward and David Goodman): “Mark Carney said U.K. interest rates may need to rise at a steeper pace than previously thought to prevent the Brexit-weakened economy from overheating. The Bank of England lifted its forecasts for economic growth… and said that inflation is projected to remain above the 2% target under the current yield curve, which prices in about three quarter-point hikes over the next three years. The governor noted that a key challenge is limited capacity. ‘It will be likely to be necessary to raise interest rates to a limited degree in a gradual process but somewhat earlier and to a somewhat greater extent than what we had thought in November,’ Carney said… ‘Demand growth is expected to exceed the diminished supply growth.’”

February 8 – Wall Street Journal (Tom Fairless): “German Bundesbank President Jens Weidmann called on the European Central Bank… to wind down its giant bond-buying program after September, urging officials not to be distracted by a stronger euro currency or volatility in global financial markets. But the ECB’s chief economist struck a more cautious note, underlining a debate within the world’s number two central bank over how quickly to phase out its aggressive stimulus policies as the eurozone economy heats up. …Mr. Weidmann said ‘substantial net [asset] purchases beyond the announced amount do not seem to be required’ if economic growth ‘progresses as currently expected.’”

February 5 – Bloomberg (Alessandro Speciale and Jonathan Stearns): “Mario Draghi said that the European Central Bank still can’t claim success in its struggle to restore inflation, and defended its policies from complaints that they widen inequalities. ‘While our confidence that inflation will converge toward our aim of below, but close to, 2% has strengthened, we cannot yet declare victory on this front,’ the ECB president said at European Parliament… ‘Monetary policy will evolve in a fully data-dependent and time-consistent manner.’”

February 8 – Wall Street Journal (Megumi Fujikawa): “Bank of Japan Gov. Haruhiko Kuroda, while declining to discuss future monetary-policy action, renewed his pledge to continue the central bank’s easy policy. ‘Japan hasn’t reached a stage where it can talk about timing or details of ways to exit from monetary easing,’ Mr. Kuroda said in a parliamentary session… The comment was made in response to an opposition lawmaker’s request that Mr. Kuroda share his exit strategy before his term expires in April.”

Global Bubble Watch:

February 6 – Bloomberg (Kana Nishizawa): “The tumble in cryptocurrencies that erased nearly $500 billion of market value over the past month could get a lot worse, according to Goldman Sachs… global head of investment research. Most digital currencies are unlikely to survive in their current form, and investors should prepare for coins to lose all their value as they’re replaced by a small set of future competitors, Goldman’s Steve Strongin said… While he didn’t posit a timeframe for losses in existing coins, he said recent price swings indicated a bubble and that the tendency for different tokens to move in lockstep wasn’t rational for a ‘few-winners-take-most’ market. ‘The high correlation between the different cryptocurrencies worries me,’ Strongin said. ‘Because of the lack of intrinsic value, the currencies that don’t survive will most likely trade to zero.’”

February 7 – Bloomberg (Shelly Hagan): “The head of the World Bank compared cryptocurrencies to ‘Ponzi schemes,’ the latest financial voice to raise questions about the legitimacy of digital currencies such as Bitcoin. ‘In terms of using Bitcoin or some of the cryptocurrencies, we are also looking at it, but I’m told the vast majority of cryptocurrencies are basically Ponzi schemes,’ World Bank Group President Jim Yong Kim said… ‘It’s still not really clear how it’s going to work.’”

Fixed-Income Bubble Watch:

February 8 – Bloomberg (Molly Smith and Austin Weinstein): “After weathering the stock-market turmoil all week, junk bonds are finally starting to show some cracks. The biggest exchange-traded fund that buys the debt clocked its worst day in more than a year on Thursday. Investors pulled money from high-yield bond funds for the seventh week in nine. That’s driving up yields for some of the market’s biggest borrowers… The cost to protect against losses on junk bonds rose Friday to its highest level since December 2016. In Asia, speculative-grade corporate notes registered a third week of losses.”

February 6 – Financial Times (Robert Smith, Kate Allen and Eric Platt): “The surge in financial market volatility spurred banks underwriting a large junk-bond sale to raise its yield on Tuesday while other high-risk debt sales were postponed. Algeco’s €1.4bn-equivalent bond sale was originally intended to close last week, but the modular building company had to push back the timing after investors demanded changes to the deal’s... Algeco announced… that it was still proceeding with the debt sale, despite a sharp sell-off across global markets, but at substantially higher yields than earlier indicated. The riskiest slice of the deal — a triple-C rated $305m unsecured bond — is set to price at an 11.5% yield, having been earlier guided at 10%”

February 5 – Bloomberg (Narae Kim and Lianting Tu): “When it comes to calling the end of the decades-long bull run in bonds, Switzerland’s Pictet Wealth Management is putting its money where its mouth is, and cutting its allocation to U.S. Treasuries. ‘Huge regime change’ is how Christophe Donay, head of asset allocation and macro research at Pictet, describes what’s going on in the bond market, with yields surging. The old simple strategy of putting 60% in equities and 40% in Treasuries, which scored handsome returns for decades, won’t work any more, he said. ‘This story is over.’”

Europe Watch:

February 5 – Bloomberg (Carolynn Look): “Economic momentum in the euro area surged to the fastest pace in almost 12 years, pushing firms to pile on the most additional workers since the start of the millennium. A composite Purchasing Managers’ Index rose to 58.8 in January from 58.1 in December, IHS Markit said.”

February 7 – Reuters (Silvia Ognibene): “The leader of Italy’s right-wing Northern League said… his party was preparing the ground to leave the euro zone and called the euro a ‘German currency’ which had damaged Italy’s economy. ‘It’s clear to everyone that the euro is a mistake for our economy,’ Matteo Salvini told reporters on the sidelines of a rally in Florence ahead of the March 4 parliamentary election.”

Japan Watch:

February 5 – Reuters: “Japanese Prime Minister Shinzo Abe said… he hoped the central bank would continue to promote ‘bold’ monetary easing to achieve its 2% inflation target. He also said it was premature to declare an end to deflation despite growing signs of strength in the economy.”

February 7 – Reuters (Leika Kihara and Stanley White): “Bank of Japan board member Hitoshi Suzuki said… the central bank could raise interest rates or slow the purchase of risky assets if the costs of prolonged monetary easing began to outweigh the benefits. The remarks from Suzuki, a former commercial banker who joined the board in July, underscored the BOJ’s dilemma as anemic price and wage growth forces it to delay normalizing policy, despite the rising cost of its radical stimulus program.”

EM Bubble Watch:

February 5 – Bloomberg (Enda Curran): “Here’s a warning sign for Asia’s central banks. Investors have started pulling out of emerging markets with the biggest slump in portfolio flows since the 2016 U.S. presidential election, according to analysts at the Institute of International Finance. Asia has taken the brunt of the reversal with South Korea, Indonesia and Thailand seeing the biggest outflows of the countries in the study. Those withdrawals have been concentrated in equities, while bonds have been hit less hard. India is bucking the trend with continued demand for both stocks and bonds.”

Leveraged Speculation Watch:

February 8 – Bloomberg (Heejin Kim): “Jim Rogers, 75, says the next bear market in stocks will be more catastrophic than any other market downturn that he’s lived through. The veteran investor says that’s because even more debt has accumulated in the global economy since the financial crisis, especially in the U.S. While Rogers isn’t saying that stocks are poised to enter bear territory now… he says he’s not surprised that U.S. equities resumed their selloff Thursday and he expects the rout to continue. ‘When we have a bear market again, and we are going to have a bear market again, it will be the worst in our lifetime,’ Rogers… said… ‘Debt is everywhere, and it’s much, much higher now.’”

February 5 – Bloomberg (Saijel Kishan): “Paul Tudor Jones said inflation is about to appear ‘with a vengeance’ and may force the new Federal Reserve chair to accelerate interest-rate hikes. The hedge fund manager said policy has focused on a ‘low inflation problem’ and years of near-zero rates amid economic expansion will have ‘painful’ consequences. Policy makers should have been more aggressive in tightening policy and ‘rejecting the fiscal impropriety associated with this most recent tax cut,’ he said. ‘We are replaying an age-old storyline of financial bubbles that has been played many times before,’ Jones, founder of Tudor Investment Corp., wrote… ‘This market’s current temperament feels so much like either Japan in 1989 or the U.S. in 1999. And the events that have transpired so far this January make me feel more convinced than ever of this repeating history.’”

February 4 – Financial Times (Eric Platt): “The most aggressive start to a year for dealmaking since Bill Clinton was in the White House had been lacking razzmatazz. Then last week private equity firm Blackstone assembled a $17bn deal for the data and terminal business of media and information group Thomson Reuters... While the deal is the biggest since the financial crisis by Blackstone — an ever more powerful force in finance over the past decade — its success will depend on a less glamorous constituency: loan and bond investors.”

Geopolitical Watch:

February 2 – Reuters (Idrees Ali): “Concerned about Russia’s growing tactical nuclear weapons, the United States will expand its nuclear capabilities…, a move some critics say could increase the risk of miscalculation between the two countries. It represents the latest sign of hardening resolve by President Donald Trump’s administration to address challenges from Russia, at the same time he is pushing for improved ties with Moscow to rein in a nuclear North Korea. The focus on Russia is in line with the Pentagon shifting priorities from the fight against Islamist militants to ‘great power competition’ with Moscow and Beijing.”

February 4 – Reuters: “China urged the United States to drop its ‘Cold War mentality’ and not misread its military build-up, after Washington published a document on Friday outlining plans to expand its nuclear capabilities to deter others. ‘Peace and development are irreversible global trends. The United States, the country that owns the world's largest nuclear arsenal, should take the initiative to follow the trend instead of going against it,’ said China's Ministry of Defence…”

Disclaimer:

Doug Noland is not a financial advisor nor is he providing investment services. This blog does not provide investment advice and Doug Noland's comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. The Credit Bubble Bulletins are copyrighted. Doug's writings can be reproduced and retransmitted so long as a link to his blog is provided.